Estimation of market value of debt.

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haiquang

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I am researching a company in tyre industry and have a problem related to market debt estimation practice.
In estimation of Equity value, I employ the formula: Equity value = FCFF - market value of debt.
The debt of the company I research includes 100% borrowings from banks with floating interest rate, the amount of debt account for 50% of the total capital. How can I estimate the market value of debt based on the Financial statements? How do you do it in practice?
Thank you very much!
 
If you know the reference rate that the debt is tied to, just use that and add whatever spread the company has to pay.
If you don’t know the reference rate, then you can probably just back into it by looking at the last quarter’s interest expense and average debt value then annualizing the quarterly interest rate.
 
If the company you are researching is large enough, there is a potential that its debt is publicly traded in the bank debt market. If so, and presuming your company provides you the research tools to access this data, observing how the debt is priced in the market would be the best way to value the bonds.
If there is no public market for your company’s debt, you will have to calculate the value mechanically, and it will require a number of assumptions. Don’t know the level of precision you are looking for here, but I’d suggest shortcuting and aggregating all of the debt together and finding the weighted average maturity, duration, coupon, etc.
- First, you will need to estimate current cost of debt. If your company has actively traded CDS, you can add the CDS spread that aligns with the weighted average duration of your bond portfolio (in bps) to a similar duration treasury. If your company doesn’t have actively traded CDS, find CDS levels of comparable companies to gauge how the market is pricing credit risk associated with obligations in this particular industry. Use these as a proxy.
- Then, use the following formula to calculate market value: [ (Sum of par values of outstanding bonds * weighted average coupon) * (1 - (1 / (1 + current calculated cost of debt) ^ (weighted average maturity) / (current calculated cost of debt)] + [ (sum of par values of outstanding bonds) / ((1 + current cost of debt) ^ (weighter average maturity)) ]
- You can do this on a bond by bond basis, if easier for you and then take the summation.
 
That answer is pretty complex for floating rate bank loans. ;)
 
^This
Map it out conceptually, the company’s interest rate payments are floating and thus directly respond to any changes in the reference rate. The risk here relates to the credit spread widening (or narrowing I suppose) - which depending on how in depth your analysis is going to be may not be required. Otherwise a much deeper analysis and assumptions must be undertook.
Disclaimer: I have never dealt with debt valuation in a professional setting - my answer could be complete garbage but thought I’d give my quick 2cents.
 
AssBackwardation wrote:
If the company you are researching is large enough, there is a potential that its debt is publicly traded in the bank debt market. If so, and presuming your company provides you the research tools to access this data, observing how the debt is priced in the market would be the best way to value the bonds.
If there is no public market for your company’s debt, you will have to calculate the value mechanically, and it will require a number of assumptions. Don’t know the level of precision you are looking for here, but I’d suggest shortcuting and aggregating all of the debt together and finding the weighted average maturity, duration, coupon, etc.
- First, you will need to estimate current cost of debt. If your company has actively traded CDS, you can add the CDS spread that aligns with the weighted average duration of your bond portfolio (in bps) to a similar duration treasury. If your company doesn’t have actively traded CDS, find CDS levels of comparable companies to gauge how the market is pricing credit risk associated with obligations in this particular industry. Use these as a proxy.
- Then, use the following formula to calculate market value: [ (Sum of par values of outstanding bonds * weighted average coupon) * (1 - (1 / (1 + current calculated cost of debt) ^ (weighted average maturity) / (current calculated cost of debt)] + [ (sum of par values of outstanding bonds) / ((1 + current cost of debt) ^ (weighter average maturity)) ]
- You can do this on a bond by bond basis, if easier for you and then take the summation.
Click to expand...
is your formula same as what it is shown in this link?
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/valquestions/mktvalofdebt.htm
 
How will this help in assigning a dollar market value to the debt he is analyzing? I realize my answer was complex, but the topic is complex, thus warranting a complex answer.
 
AssBackwardation wrote:
How will this help in assigning a dollar market value to the debt he is analyzing? I realize my answer was complex, but the topic is complex, thus warranting a complex answer.
Click to expand...
Was trying to build up to what your explation detailed - ableit in a poorly worded fasion. Was trying to highlight that since the debt was floating, the key issue is whether or not credit spreads are different now than when the debt was issued. If they haven’t materially changed, then the future interest payments will be discounted at their inverse and the debt would approximately equall the current principle outstanding (i.e. whats currently on the books). If they have changed, your explantion is golden.
Basically, trying to hightlight the simple case in which the spreads havn’t changed since the issuance, as a lead in to your case which assumes they have (your calcualtion is of course more exhaustive and correct in either state of the world).
 
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